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The last year was a brutal time to be an investor in the junior mining sector – the worst that I’ve seen in more than 30 years in the industry. After that painful experience, now is a good time to be investing in this sector: BUT, in very selective companies.

We are all familiar with many of the reasons for that broad sell-off: Investors shunned risk in the face of extraordinary global financial uncertainty. The gold companies delivered disappointing operating performances, driving many investors away from the gold sector. The lack of upward movement in the commodity prices and the perception of further downside risk in metal prices have all added to the unfavorable investment climate. The net result has been that shares of nearly all junior mining companies have been clobbered, the good along with the bad.

 

Another Factor That Is Depressing Junior Resource Stocks

There is another factor that many are probably familiar with, but you may not appreciate its magnitude. During 2010 and 2011, there was an extraordinary amount of new capital coming into the junior mining sector. Just looking at the Toronto Stock Exchange Venture board, there was $20 billion of new primary investment in TSXV-listed companies.

 

Roughly three quarters of the companies on the venture board are mining related, implying about $15 billion worth of new share certificates were created over a two year period, more than at any other time. That was a period of irrational exuberance, with the Venture index coming off the low point in early 2009 to triple by early 2011.

 

During that time of exuberance, Fund managers seemingly suspended their judgment and due diligence, making private placement investments into an astounding array of companies, many with questionable geological merit.

 

Unfortunately, much of that new money failed to generate any real value for shareholders. A lot of it was eaten up by management salaries, head office rent and investor relations activities. A portion of it funded drilling programs aimed at making new discoveries. Very few new discoveries resulted from all that geophysics, trenching and drilling.

 

There was $15 billion of new money added in those two years. Today, the total value of the TSXV-listed mining companies is $11 billion and still falling.

In my opinion, many exploration and development companies are still trading at share prices well above their fundamental value. The ongoing sinking feeling of so many companies declining in price is creating the impression that the whole market is still declining. Indeed, many share prices still have a long way to fall, even if they are now at a level of a few pennies. Over the past few weeks, tax-loss selling has added to the downward pressure on prices.

 

Share Prices Are Reacting to Various Forces

There are a number of factors that influence the different trajectories of the various companies.

Some people like to speculate on a new discovery. Finding a big new metal deposit can be enormously rewarding for shareholders: We recently saw GoldQuest go from a nickel to $2 in a matter of weeks. Unfortunately, new discoveries are few and far between.

 

Many people invest in resource companies on the basis of the expectation of rising metal prices. That works as long as the company actually holds some of the metal in question. You won’t get much leverage to a metal price off a company’s best intentions to make a discovery next week.

 

Another big pit-fall is to get caught up in the various fads that go through the sector. For example, there is enormous merit in the fundamentals of the critical elements story, or graphite, or lithium or whatever the story. It’s just that most of the companies that get caught up in the flavor-of-the-month fads have little to contribute to the fundamental story.
Looking For Companies Which Are Adding Value

Another approach, and the main driving force in all of the companies listed above, is to seek out companies that have a high-quality metal deposit in hand. In this way, you avoid the discovery risk, yet there is still potential for enormous gains. For example, a gold deposit with widely spaced drilling and which is classed as an inferred resource will be valued by investors at just $10 per ounce of gold in the ground. By the time those same ounces advance to production, the value per ounce has increased by 30 or 40 times.

 

Finding companies with high quality metal deposits

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